Most believe money was invented to facilitate trade, but because preserving wealth through inheritance and marriage both predate trade, transferring wealth was more urgent than trade. Therefore, the need to transfer wealth led to man’s creation of money.
Money and Wealth Transfers
Furs, teeth, beads, pendants and shells were discovered as early as 40,000 years ago in Europe1. These collectibles were made during a period when the process was both time consuming and required a strong skill set, which gives credence to the idea that ancient tribes used collectibles as a means of storing and transferring wealth. These were the earliest known forms of currency.
It was particularly important that the method of transfer was a) durable, meaning the wealth didn’t have an expiry date and b) general, meaning it would be considered valuable by the highest number tribes, making it repurposable. This increased the likelihood of survival, as tribes could trade their collectibles for food during times of hardship.
The value humans place upon these items has led some experts to postulate that we have a collection instinct and feel pleasure as a survival mechanism. In part, this explains our urge not only to reach down and pick up a beautiful shell, but to then take it home and paint or decorate it to increase its perceived value.
Interesting Facts About the Origins of Money
1. Money was commonly used to compensate for value mismatch between bride and groom in marriages, and almost always from groom to bride, as women were more valuable than men between clans.2
2. Victors in war would accept payment in the form of collectibles, ending the need for battle. This benefitted both the victor, who could increase their wealth by taxing the defeated, and the vanquished, who could preserve their lives in exchange for a paid tax.3
The first coins have been traced back to what is now Libya, beginning in 700 B.C. Physical currency allowed for more trades than the bartering system. Low-value trades became possible as small gains from trade exceeded transaction cost. Whereas collectibles were low velocity and reserved for high-value transactions, coins were high-velocity money facilitating low value trades.
Coin money solved two problems that plague a barter economy: the coincidence of wants and scalability. The coincidence of wants occurs when two parties each hold an item the other desires, so they exchange these items directly without any monetary medium. Naturally, this dramatically limits the possible transactions that can take place, which in turn hinders economic growth and prosperity.
Scalability was limited due to the sheer number of possible prices within a barter economy. Since X products require X2 prices, 100 products translate to 10,000 prices. However, using money, 100 products merely require 100 fixed prices. Because 10,000 prices were far too varied for any one person to keep track of, the inability to assign value significantly reduced trade.
By serving as a portable, durable and divisible medium of exchange, as well as a unit of account, coins revolutionized commerce and society. Scientists estimate that approximately 100,000 years ago, Homo Sapiens Sapiens (modern humans) experienced a 10x population increase, despite weaker bones and no growth in brain size. Experts believe this occurred due in part to social institutions made possible by wealth transfer, as well as the development of language.
Money needed to be easy to carry or hide and hard to forge (making it scarce), and the process of measuring its value needed to be simple. With collectibles, it was difficult to satisfy all three properties simultaneously. Coin money solved this problem effectively and efficiently.
For a more thorough history of money’s origins, I highly recommend Nick Sbazo’s riveting work, Shelling Out: The Origins of Money. (Audio version here).
The Three Types of Monetary Systems
For thousands of years, three types of monetary systems have existed: hard money (metal coins), paper money (claims on hard money), and fiat money (the U.S. Dollar today).4
Gold and silver are considered “hard money” or “good money” because their supply is relatively stable, and they are said to have intrinsic value (we’ll discuss this more in a future post). Using coins as money is quite limiting because money and credit cannot be easily created. Even more limiting is physical bullion (bars, ingots, or coins), which can be cumbersome to transport, making its trade even more difficult when compared to paper money.
These limitations lead societies to adopt a “paper money” system, where the hard money (gold) can be exchanged for the paper money. This peg allows those who hold the money (banks) to increase the ratio of paper relative to coinage, facilitated through lending. This benefits both the lenders (banks), who charge interest, as well as the borrowers (citizens), who can now purchase things they otherwise couldn’t with less capital.
Lending and borrowing leads to an increase in production and a rise in asset prices. This cycle continues until there is more debt than there are goods and services available for purchase. Next, people begin to default. Historically, as people realize there are more claims on money than there is money in the bank, this leads to bank runs, where depositors rush to withdraw their money to avoid being stuck with paper.
Bank runs lead to either defaults or government bailouts, in which the central bank prints money if the debts are denominated in their national currency. Since the latter is less painful, it’s often the chosen path.
In the third type of system, “fiat,” which means backed by government order, governments are free to create money and credit in whatever quantity they please.
Just like the paper money system works insofar as people don’t run on the banks, a fiat system works for as long as people have confidence in the government’s ability to repay its debt. This is what it means to have faith in one’s system of currency.
Governments transition through these three systems for a variety of reasons, most commonly to fund wars.
For a more thorough synopsis, I highly recommend Ray Dalio’s latest series, The Changing World Order. Dalio has also published a half-hour video summary on YouTube.
Lessons from Monetary History
While gold and silver have maintained their value throughout history, every single fiat currency has either failed or been devalued immensely through debasement of the supply.
This happens when the cycle of the third system has run its course (when too much money is created, causing its value to depreciate and people to rush back to other store holds of wealth, including hard assets such as gold and silver).
Then, we begin again.
History is littered with examples of these cycles, which typically last 50-75 years and repeat like clockwork.5
These cycles end gradually, then suddenly, and large amounts of wealth are transferred from those stuck with fiat to those who hold hard assets.
Think of it like a game of musical chairs: Everyone sings along merrily until the music stops. The players scramble to get a seat, but the nature of the game dictates that there cannot be an empty seat for every person playing.
This is analogous to what happens during a bank run or currency crisis when fiats’s fail. If I could sum up what I’ve learned as simply as possible, it would be to keep a close eye on the nearest chair.
Our Current Monetary System
The U.S. Dollar became the world’s reserve currency at the end of World War II, not only because the U.S. was the strongest economic and military power of the era, but because the country had prospered immensely during the war (from exporting goods to Europe while not having to fight on its own land). This resulted in the United States’ possessing roughly two-thirds of the world’s gold, which at the time, was money.
Our current world order is famously known as the Bretton-Woods system, since heads of state from around the world traditionally meet in Bretton Woods, New Hampshire to agree upon such matters.
This Type 2 monetary system uses a paper dollar, which represented a claim on gold and was redeemable for bullion at a price of $35/ounce. The rest of the world was backed by dollars, which were backed by gold, thereby linking the entire world’s monetary system to gold through the U.S. Dollar.
ALL CURRENCIES = U.S. DOLLAR = GOLD
Being the world’s reserve currency is a superpower, as it allows a country to create widely- accepted money and credit, thereby increasing its economic dominance relative to other countries.
The US Federal Reserve (often referred to as “the Fed”), a privately-owned institution created in 1913 which controls the nation’s money supply, is the central bank of the US. In the years that followed the Bretton Woods agreement, the U.S. government spent more than it accrued in tax revenue, so it was forced to borrow money from the Fed. Naturally, this led to the creation of more claims on gold that exceeded the amount of gold that actually existed.
Over time, governments around the world began turning in their claims on gold for actual gold, causing the quantity of gold held in the U.S. Treasury to diminish. Realizing they would soon not be able to pay all of their debts, the convertibility of dollars into gold ended on August 15th, 1971 under President Nixon. This moved the U.S. (and subsequently all of the world) to a Type 3, fiat monetary system, which is how we currently operate.
The Monetary Cycles
The creation of money and credit stimulates the economy when it’s being created and distributed, but it has the opposite effect when it’s retracted. This is partly what makes money, credit and economic growth cyclical.
To boost the economy, the Fed reduces the cost of borrowing by lowering interest rates, which incentivizes people to borrow, invest and spend. Too much growth, and they do the opposite, raising the cost of capital, which thereby decreases borrowing and spending.
Think of the Fed as having its foot on the pedal of the US economy in the form of a vehicle, pushing down or letting up depending on where it is in the cycle. When there’s less activity, the Fed lays down a heavy foot, and when there’s too much activity, they pull away.
The efficacy and ethicalness of the Fed to stimulate or restrict is widely debated, but the degree to which they can do so is limited in scope, as they can only control the economy as it relates to their ability to produce money and credit.
These expansions and contractions happen in relatively predictable cycles, both short and long term. The short-term debt cycle typically lasts eight years and occurs when the demand to borrow and spend exceeds the limits of the economy’s capacity to produce real goods and service. The most recent of these occurred in 2007 and is commonly referred to as the Great Financial Crisis. More broadly, these cycles are referred to as “the business cycle.”
Over longer periods of time, the cumulation of these short-term cycles produces a longer-term cycle (in which the lows are of the latest cycle aren’t as low as the cycle which preceded it) that lasts between 50-75 years.
Since these cycles happen once in a lifetime, most people are unaware of them and because they occur gradually, then suddenly, it takes people by surprise and causes great financial hardship.6
Because these cycles happen once in a lifetime (and require an esoteric understanding of the economy to fully understand), most people are unaware of them. They occur gradually, suddenly taking people by surprise and causing devastating financial hardship before the average person even knows what hit them.6
The long-term debt cycle ends when both corporate and individual debt is high, interest rates cannot be lowered further, wealth gaps are significant, and money creation increases the price of financial assets faster than economic activity.
When this occurs, those who hold the debts no longer believe it’s a viable store of value and look to store their wealth elsewhere. This results in a slow, then abrupt, movement of capital from fiat back into real or “hard” assets. If and when too much capital leaves and faith in the currency is lost, a restructuring of the monetary system becomes necessary.
History teaches us that among other things, people always turn to gold and silver, at which point the price of these assets (along with the other store holds of wealth) essentially does an accounting of sorts and rises to meet the quantity of currency that was created.7
Where Are We Now?
The current New World Order began in 1945, exactly 75 years ago. Following the crippling conflict of WWII, there was a period of peace and prosperity. Income growth kept pace with credit expansion, creating a stable economy, while the central banks had plenty of “liquid in the bottle” to stimulate economic growth if necessary.
There were short-term cycles (recessions and expansions), but with each passing cycle, the previous low was higher than the past cycle, causing a general upward trend.
Over time, wealth gaps increased, as not everyone had equal access to credit, and naturally, some produce more than others. These short-term boom and bust cycles have continued until today, forming a long-term cycle. Today’s differentiator is that now with interest rates at zero percent, central banks have virtually run out of their ability to stimulate credit and economic growth.
Historically, this has led to conflict within and between countries over wealth and power, which leads to revolution or wars, some of which are peaceful, but most of which are violent.
When this happens, central banks typically print more money to fund these wars, ultimately leading to a restructuring of debts, the money system and both the domestic and international order, typically referred to as the “world order.”
Many experts believe we’re at the end of the long-term debt cycle. In retrospect, people will blame the coronavirus, but in reality, the culmination of the cycle has been building for years. Covid-19 is merely the pin that burst the bubble, albeit at an accelerated rate.
Many things could have burst the bubble, and history shows us that although no two cycles are the same, they share similar characteristics.
Currently, wealth gaps have reached near all-time highs8910, nearing those of the Great Depression, with the top 1% owning 82% of the wealth generated in the last year.
The recent “debt bust” has fueled unprecedented money printing11, and it seems we are at the “Printing Money and Credit” phase. From what I gather, we seem to be at the end of both the short-term debt cycle, the last 11 years of which have been the longest expansion in history, and the long-term debt cycle, which is also beginning to unwind.
What Happens Next?
This once-in-a-lifetime event is something we’ve never witnessed before, as the last long-term debt cycle unwound in 1929 (when The Great Depression began) and lasted several years. While it’s impossible to know exactly what the future holds, cycles reveal emerging patterns that we can learn from.
In the next episode of “The Future of Money,” we’ll take a look at the implications of everything mentioned above, where things could be headed, and what a new world order could look like.
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- Shelling Out – The Origins of Money
- Shelling Out – The Origins of Money
- Shelling Out – The Origins of Money
- Ray Dalio. https://www.linkedin.com/pulse/money-credit-debt-ray-dalio/
- Ray Dalio: https://www.linkedin.com/pulse/big-cycles-over-last-500-years-ray-dalio/
- How the Economic Machine Works in 30 Minutes Ray Dalio: https://www.youtube.com/watch?v=PHe0bXAIuk0
- Mike Maloney https://www.youtube.com/watch?v=EdSq5H7awi8&list=PLE88E9ICdipidHkTehs1VbFzgwrq1jkUJ&index=2
- Wealth Gaps: https://www.pewsocialtrends.org/2020/01/09/trends-in-income-and-wealth-inequality/
- 82% of Wealth Generated Last Year Went to Richest 1% of Global Population: https://time.com/5111971/billionaires-global-inequality-income-oxfam-wealth/
- Money Printing: https://www.forbes.com/sites/greatspeculations/2020/08/10/money-explodes-gold-glitters-the-recovery-slows/#64bd87d9cb3b
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